Essays on emissions trading markets

Abstract

This dissertation is a collection of three economics essays on different aspects of carbon emission trading markets. The first essay analyzes the dynamic optimal emission control strategies of two nations. With a potential to become the largest buyer under the Kyoto Protocol, the US is assumed to be a monopsony, whereas with a large number of tradable permits on hand Russia is assumed to be a monopoly. Optimal costs of emission control programs are estimated for both the countries under four different market scenarios: non-cooperative no trade, US monopsony, Russia monopoly, and cooperative trading. The US monopsony scenario is found to be the most Pareto cost efficient. The Pareto efficient outcome, however, would require the US to make side payments to Russia, which will even out the differences in the cost savings from cooperative behavior. ^ The second essay analyzes the price dynamics of the Chicago Climate Exchange (CCX), a voluntary emissions trading market. By examining the volatility in market returns using AR-GARCH and Markov switching models, the study associates the market price fluctuations with two different political regimes of the US government. Further, the study also identifies a high volatility in the returns few months before the market collapse. Three possible regulatory and market-based forces are identified as probable causes of market volatility and its ultimate collapse. Organizers of other voluntary markets in the US and worldwide may closely watch for these regime switching forces in order to overcome emission market crashes.^ The third essay compares excess skewness and kurtosis in carbon prices between CCX and EU ETS (European Union Emission Trading Scheme) Phase I and II markets, by examining the tail behavior when market expectations exceed the threshold level. Dynamic extreme value theory is used to find out the mean price exceedence of the threshold levels and estimate the risk loss. The calculated risk measures suggest that CCX and EU ETS Phase I are extremely immature markets for a risk investor, whereas EU ETS Phase II is a more stable market that could develop as a mature carbon market in future years.^